Gilt Fund
A gilt fund is a debt mutual fund that invested exclusively in government securities — bonds issued by the central or state governments of India — carrying zero credit risk since the Indian government was considered the most creditworthy borrower in the domestic market.
The term 'gilt' originated from British financial markets, referring to the gold-edged certificates that historically represented government bond ownership. In India, gilt funds as defined by SEBI's 2017 categorisation circular invested at least 80 percent in government securities across maturities. A separate sub-category — gilt funds with 10-year constant duration — required maintaining a Macaulay duration of at least 10 years, giving investors targeted exposure to long-duration sovereign risk.
The absence of credit risk was gilt funds' defining characteristic and primary appeal. Unlike corporate bond funds or credit risk funds, a gilt fund investor faced no possibility of a default by the issuer, since the Government of India could theoretically always meet its debt obligations in rupees through taxation or currency issuance. For conservative investors, particularly retirees or institutions, this made gilt funds structurally safer than any corporate debt alternative.
However, the elimination of credit risk in gilt funds was accompanied by a concentration of interest rate risk. Government securities, especially long-duration bonds, were among the most interest-rate-sensitive instruments in the debt market. When the RBI raised policy rates, the prices of existing bonds fell sharply and gilt fund NAVs declined materially. Conversely, in rate-cutting cycles, gilt funds delivered exceptional returns. The 2014–2016 period, when the RBI cut rates by 125 basis points, saw long-duration gilt funds deliver 15–20 percent annual returns — returns that many investors mistook for representative performance.
The relationship between duration, yield changes, and price changes was governed by the modified duration of the portfolio. A gilt fund with a 10-year modified duration would see its NAV fall by approximately 10 percent for every 100-basis-point rise in yields, and rise by approximately 10 percent for every 100-basis-point fall. This made gilt funds unsuitable as short-term parking instruments and appropriate only for investors with strong views on the rate cycle or with long investment horizons.
Post April 2023, gains from gilt funds were taxed at the investor's slab rate regardless of holding period, eliminating the earlier indexation benefit for long-term gains. Gilt funds therefore lost some of their post-tax return advantage over bank FDs for investors in higher tax brackets, though they retained advantages in terms of mark-to-market transparency and absence of TDS for resident investors below applicable limits.